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Best Practices: SBA’s Proposed Change to the Affiliation Rule

by Katie O'Brien

In order to be eligible for an SBA loan, an applicant must be “small” in accordance with SBA’s size requirements. (See 13 CFR 120.100). To determine an applicant’s size, a lender must determine whether the applicant has affiliates (as defined by 13 CFR 121.103).

Generally, affiliation exists when one business controls or has the power to control another business (or when a third party controls or has the power to control both businesses) through common ownership, management or other relationships between the parties. If an applicant is determined to have affiliates, the affiliates’ receipts and employees are added to those of the applicant in order to determine size under SBA’s regulations. Some applicants are determined to be ineligible for SBA loans because they exceed SBA’s size standard.

On February 25, 2013, a notice of proposed rulemaking for the SBA was published in the Federal Register. One proposed change is a simplification of the affiliation rules, with the goal of creating a simple, bright-line test for determining eligibility that reduces the documentation requirement for applicants while still protecting program integrity.

One of the proposed changes sets forth a new way to determine affiliation based on common ownership. Under the proposed rule, when no one person owns or has the power to control more than 50% of the voting equity of the business, the CEO or President (or other officers or members who control the management of the business) is deemed to have control of the business. If one person owns or has the power to control more than 50% of the voting equity of the business, that individual is deemed to have control. Additionally, if two or more persons collectively own or have the power to control more than 50% of the voting equity of two or more businesses, then affiliation would exist between those businesses (and between each business and each owner).

Another significant proposed change is that SBA would no longer require lenders to consider negative control (such as when a minority shareholder has the ability to prevent a quorum or block action of the shareholders or board of directors), by itself, as a factor when determining affiliation.

SBA has also proposed that it would no longer apply existing affiliation principles related to identity of interest, newly organized concerns and joint ventures. For a detailed discussion of these changes, see the full proposal set forth at http://federalregister.gov/a/2013-04221.

In order to make sure that the changes do not compromise program integrity or lead to a lack of oversight, and to improve consistency and expedite review of applications, SBA has proposed the addition of a requirement that an applicant execute an affidavit in which the applicant certifies that all persons affiliated with the applicant have been identified in the affidavit. The Agency expects this affidavit requirement to be less burdensome on applicants than the current practice of submitting tax documents and financial statements in order to determine affiliation. Lenders will need to consider the effect that this affidavit has on their due diligence requirements, and will need to ensure that they comply with their own policies as well.

Despite the proposed changes to the affiliation rule, the SBA will maintain a “totality of the circumstances” standard to allow the SBA and lenders to determine that an application is ineligible if the totality of the circumstances lead to the conclusion that affiliation exists, although no single factor alone constitutes affiliation.

For more information regarding the current proposed changes to the SBA regulations, contact Katie at (215) 542-7070 or KOBrien@StarfieldSmith.com.